How Internet Traffic is Increasing Network Equipment Spending, Part I

It wasn't a question of if, but when. The cessation in Internet infrastructure spending after the bubble burst in 2001 that decimated the communications equipment industry  left many investors quite wary of treading back into these waters.  

But after a five-year drought, service providers and enterprises are, once again, spending on network infrastructure.

This fact has in turn propelled stocks like Cisco Systems (CSCO), Foundry Networks (FDRY), and Juniper (JNPR) to new multi-year highs as investor pessimism has turned to optimism.

So why the newfound optimism in the networking stocks?

It's well known that Internet traffic is on the rise and companies and consumers are becoming increasingly tied to the web. But what makes this time different?

Considering the destruction and ensuing fallout the last time around, the enduring skepticism is understandable.

We would argue, however, that this time capital budgets are being supported by cash-rich balance sheets and not stock valuations.

It all started with Cisco's surprisingly upbeat quarter a year ago last summer that told the world that its business was rebounding.

Cisco's stalwart performance over the past year has solidified the view that equipment spending is on the rise and the networking equipment giant's "Phase II" view of the Internet build out cycle is gaining credibility. This week Cisco raised its long-term growth rate to the 13-16% range.

The main propellants of escalating capex include broadband proliferation, intensifying competition between cable companies and telecom carriers, and emerging market network build outs.

The important factor to consider this time around is the fact that demand is being driven by all three markets - carrier, enterprise, and consumer - and on a global scale. While large scale network build outs are driving spending in the emerging markets like India and China, US spending is focused on network efficiencies and optimization.

Service providers are defined as wireline, wireless, cable operators, and major Internet content providers and the enterprise market consists of network intensive enterprises, federal, state, and local governments, and research and education institutions.

Carriers from around the globe are in the process of migrating voice traffic onto IP data networks, creating an enormous demand for IP equipment and network solutions.

New architectures and applications will drive a similar cycle on the enterprise side, while the consumer segment will be driven by the demand to deliver content wherever, whenever, and however users desire.

At the most fundamental level, the growth catalyst for the equipment suppliers is simply - the amount of traffic (video, business services, VoIP etc.) going across carrier IP (Internet Protocol) networks will continue to grow.

As a result, this will increase the amount of carrier capital expenditure devoted to IP equipment and software.

 In Part II posted this Friday, we'll take a closer look at the carrier router market.

--Kimberly DuBord, Briefing.com